Disclaimer: I'm a brand spanking new member, and did my duty by checking past posts but couldn't find a similar thread. My apologies if this has been discussed ad nauseum.

Here's my confusion. My husband and I are newlyweds, and by definition, are now finally getting serious about investing for retirement. We'd like to open an IRA. Now, I like the flexibility of the RIRA, and we more than qualify right now income-wise. BUT we're on a track where that will change sort of quickly (within 5 yrs) and we won't be eligible for too terribly long. I realize it makes sense to have both. Problem is, we can't afford to open both right now. Which is best first? The Roth while we're eligible, or the traditional?

Which is best first? The Roth while we're eligible, or the traditional?

I would definitely put the $$$ in a Roth, especially since you may not be eligible for it in the near future. There's a couple of reasons why:

1. You pay taxes on your contributions now (at your current tax rate) rather than at a future (higher, most likely) tax rate later on.

2. You can take out your contributions from a Roth IRA penalty-free at any time. I'm of the opinion that the more flexible the money is, the more powerful it is.

3. "Tax Diversification" purposes. While the Roth IRA looks like a great deal now, Congress can change that in a heartbeat. Since you'll be forced to start contributing to a Traditional IRA in the foreseeable future, I would want some investments which are still tax-advantaged, but advantaged in a different way. So, you are less susceptible to changes Congress decides to make.

4. You can put more "after-tax" money in a Roth than you can in a Traditional. In effect, you're saving more of your income, because you divide your $3,000 contribution by your after-tax income rather than your gross income. So, while it's still $3,000 either way, with a Roth, all of the $3,000 is YOUR money. In a Traditional IRA, you're in effect investing for both yourself and Uncle Sam. The better you do, the better he does.

While I am inclined to agree with Agg97, for the sake of argument let me suggest some reasons why you might want to consider the tax deductable traditional IRA.1. I will save you in taxes right now. The contribution amount lowers your taxable income.2. You MIGHT be in a lower tax bracket when you withdraw the funds.3. Many think that the longer you can postpone taxes on money the better. The validity of this argument depends to a great extent what current and future tax rates are.4. Another view of Agg97's fourth point is that Uncle Sam is letting you use their money to invest from now until retirement.

The Roth IRA is very attractive but wanted you to think about the other side also.

I agree with the Roth over traditional IRA in for 99% of the situations but there are a few assumptions that are built into this.

1) Everything goes as planned and you make gobs of money up until you retire. I can't count the number of people I know that have had some sort of major career or health upset that they weren't expecting. Even if nothing bad happens, your priorities may change and your careers may take a backseat to your quality of life.

2) You will want to work until a typical retirement age of sixty something. You may end of having the choice of retiring ten or fifteen(or even twenty!) years earlier and living a more modest lifestyle, if you do this then you may actually end up being in a lower tax bracket when you retire. For example if you decide to retire in your early fifties, with your house paid off, then how much income do your really need to live a modest lifestyle. I am guessing that you and your spouse are probably in your twenties or early thirties, if so then with the income you are expecting, a very early retirement is possible.

3) I agree that money in a Roth IRA is much better than then same amount in a traditional IRA but if I read you post correctly you can't currently afford to max out the IRA's. So the choice is more like either $3000 in a Roth or approximately $4000 in a traditional IRAs to be the same after taxes in this tax year. The additional money in the traditional IRA tends to lessen the advantage of the Roth IRA.

4)It assumes that you will retire in a state with similar income taxes to the state you are currently working in. As I recall reading, New York has extremely income high tax rate that you would be paying for any money contributed to a Roth IRA. If you worked in New Your then ended up retiring in a state like Washington or Texas that does not have a state income tax, then you will end up having lost a lot of the Roth advantage.

Like I said, I agree the Roth is probably the way to go. With all of the possible changes that are possible in the future this is probably all guesswork anyway. The important thing is that you invest the money somewhere.

3. Many think that the longer you can postpone taxes on money the better. The validity of this argument depends to a great extent what current and future tax rates are.

IMHO, this isn't a strong argument. That applies more to selling individual stocks and how much capital gains you want to realize. When the amount of YOUR money is affected (such as $3,000 after taxes in a Roth IRA versus $2,250 after taxes assuming you're in the 25% marginal tax bracket in a traditional IRA)

4. Another view of Agg97's fourth point is that Uncle Sam is letting you use their money to invest from now until retirement.

True, but not a strong argument for the same reason as above. To make this an even comparison, you'd have to invest the remaining after-tax amount to make it equivalent to the Roth. Then you're limited to investments which aren't hammered by taxes on an annual basis, which limits your choices. Limiting choices is a good way to decrease returns on investments.

3) I agree that money in a Roth IRA is much better than then same amount in a traditional IRA but if I read you post correctly you can't currently afford to max out the IRA's. So the choice is more like either $3000 in a Roth or approximately $4000 in a traditional IRAs to be the same after taxes in this tax year. The additional money in the traditional IRA tends to lessen the advantage of the Roth IRA.

I'm a little confused by this argument, Greg. What additional money are you referring to? AFAIK, we are currently limited to $3,000 total, whether you pay taxes now or later.

With all of the possible changes that are possible in the future this is probably all guesswork anyway.

I agree 100% with this statement. It's kind of like poker, really. All you can do is maximize the chances that you have control of...but there's Lady Luck (or Uncle Sam as it were) that can make you or break you at any moment.

How embarrassing. I didn't finish my argument to the first one. I must have been too tired and reformatted the post a couple times without proofreading it.

3. Many think that the longer you can postpone taxes on money the better. The validity of this argument depends to a great extent what current and future tax rates are.

IMHO, this isn't a strong argument. That applies more to selling individual stocks and how much capital gains you want to realize. When the amount of YOUR money is affected (such as $3,000 after taxes in a Roth IRA versus $2,250 after taxes assuming you're in the 25% marginal tax bracket in a traditional IRA), then you're trying to squeeze a "one size fits all" statement to something with more complex issues.

3) I agree that money in a Roth IRA is much better than then same amount in a traditional IRA but if I read you post correctly you can't currently afford to max out the IRA's. So the choice is more like either $3000 in a Roth or approximately $4000 in a traditional IRAs to be the same after taxes in this tax year.The additional money in the traditional IRA tends to lessen the advantage of the Roth IRA.

I'm a little confused by this argument, Greg. What additional money are you referring to? AFAIK, we are currently limited to $3,000 total, whether you pay taxes now or later.

The traditional IRA $4000 figure came from assuming that the marginal tax rate was something like 25% so that contribution to the TIRA instead of the Roth would result in about a $1000 tax savings, which would have the same net after-tax effect(in the current year) as a $3000 Roth contribution.

It is true that there is a $3000 limit per person but since they are a married couple, they can each contribute up to $3000 for a total maximum of $6000 dollars. If they wanted to contribute a total of $4000 this year they could contribute $2000 to each of their accounts. Starting a few years ago, even if one of the spouses is not working they can still both make IRA contributions.

We'd like to open an IRA. Now, I like the flexibility of the RIRA, and we more than qualify right now income-wise. BUT we're on a track where that will change sort of quickly (within 5 yrs) and we won't be eligible for too terribly long. I realize it makes sense to have both. Problem is, we can't afford to open both right now.

Your statements that you currently have low enough income to qualify for a Roth and that you can't afford to open both RIRA and TIRA right now--cause me to assume that you're not in a terribly high tax bracket, plus you don't live in NY, but Indiana, where I'm also assuming you don't pay high state and local taxes. These assumptions of mine lead me to believe that the advantages of the TIRA deductibility for you are not that great.

Plus you state that you're assuming/hoping your income will increase in a few short years and you'll no longer be eligible for a Roth. I am not eligible for a Roth because of my income--I WISH I was. I agree with all of Agg97's statements, particularly the part about flexibility, and would put the money in a Roth while you can. Even if your income doesn't rise enough that you become ineligible, in later years you could always go with the TIRA if you wanted to take advantage of the deduction as your income rises.

If, based on all the viewpoints you've heard, you're still torn between the two, you could always split the $3000 between a RIRA and a TIRA--$1500 in each. Vanguard will open either of these accounts with a $1000 minimum, but it may cost you a bit more in annual fees.

>>Which is best first? The Roth while we're eligible, or the traditional?

If you can max out either IRA, the Roth is better. If you can't (ie, you're in a 10% tax bracket so can contribute $1000 to the TIRA or $900 to the Roth) it doesn't matter, since the better choice depends on your (non-predictable) retirement tax rate. You might go with the Roth just to diversify, if you're pretty sure you won't be eligible for it in the future. Go with the TIRA if you think you might be tempted to withdraw your principal from the Roth at some future date.

>>Problem is, we can't afford to open both right now.

If you can afford one, you can afford both, since the combined maximum is the same as the maximum for a single type.

While the Roth IRA looks like a great deal now, Congress can change that in a heartbeat. Since you'll be forced to start contributing to a Traditional IRA in the foreseeable future, I would want some investments which are still tax-advantaged, but advantaged in a different way. So, you are less susceptible to changes Congress decides to make.

I have done some thinking on this statement, and I don't it is a realistic concern. If the government makes a change, they will make it applicable from some point in time forward. In all cases I can think of pertaining to tax code, they always 'grandfather' previous commitments when retirement is involved.

Can you imagine how fast our elected politicians would be voted out of office if they cancelled or reduced the tax-free status of money in ROTH IRAs? The 'Baby Boomers' will be the most powerful voice in the country for the next 30 years or so, and lots of them have ROTH IRAs (including me).

"Can you imagine how fast our elected politicians would be voted out of office if they cancelled or reduced the tax-free status of money in ROTH IRAs? The 'Baby Boomers' will be the most powerful voice in the country for the next 30 years or so, and lots of them have ROTH IRAs (including me)."

Yes, but I've thought about this too. I don't trust them to keep Roth's untaxable any more than I trust them to leave the SS retirement age at 65 (oops - they already changed that didn't they??- with more changes to come I'm sure.) They'll exclude from tax the amounts you contributed - after all, you paid tax on that money already. And they'll sell it to the majority of voters 10 or 15 years from now, because those people will be living a much lower standard of living than us "wealthy" retirees. Just like so many states now are "taxing the rich" - the only "rich" left will be the baby-boomers. (Except of course the truly wealthy who have foundations, tax accountants, and special tax shelter laws passed by their friends the politicians.)

I don't trust them to keep Roth's untaxable any more than I trust them to leave the SS retirement age at 65 (oops - they already changed that didn't they??- with more changes to come I'm sure.)

True, but they have never taken away a benefit that has already been bestowed on anyone. In the case of social security, they may delay or cancel benefits that you were supposed to get, but they will never reduce benefits already given.

In the case of a Roth IRA, with the income taxes already paid, I don't think they will ever tax the money a second time using income taxes. Of course, they could devise some sort of 'wealth tax', like the 'intangibles tax' in Florida, where they simply levy a tax against the size of your equity portfolio, but that would likely affect any kind of account; not just a Roth.

"don't trust them to keep Roth's untaxable any more than I trust them to leave the SS retirement age at 65 (oops - they already changed that didn't they??- with more changes to come I'm sure.)"

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"True, but they have never taken away a benefit that has already been bestowed on anyone. In the case of social security, they may delay or cancel benefits that you were supposed to get, but they will never reduce benefits already given."

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Remember when social security benefits were not taxed? Remember when anyone, regardless of income, could contribute $2000 pre-tax to a traditional IRA?

They can change anything they want. When Roth distributions start totaling big $$$ and Congress needs money to reduce growing deficits they'll figure out a way to tax Roths too.

They can change anything they want. When Roth distributions start totaling big $$$ and Congress needs money to reduce growing deficits they'll figure out a way to tax Roths too.

Every time any of us puts money in a Roth, we are betting on the rules staying the same. It would be total political suicide for any politician to vote to change the rules for money already inside a Roth. They may change the rules to disallow Roth's in the future, but that won't affect the money already in Roths. They always grandfather old programs while they phase them out to new people.

Remember when anyone, regardless of income, could contribute $2000 pre-tax to a traditional IRA?

Yes, and that affected future contributions and not money that was already inside an IRA.

In fact, I challenge you to find one single example of a tax law change that changed the tax treatment of money already inside a retirement program of any kind. This is sacred ground for the politicians.

It is much more likely that they will simply raise the income tax marginal percentages to increase revenues. After all, the really big IRA's are the Traditional ones, from 401(k) and pension rollovers, and money withdrawn from those is taxible at the marginal rate. That's how they'll help to balance the budget. Especially when RMD's kick in.

One way to surreptitiously tax money in Roth IRA's would be to institute a national sales tax. This could be done in the name of tax simplification and could accompany a decrease in income tax rates. Then, anytime you bought anything with Roth money, you would be paying taxes that you don't pay now.

spinning wrote:One way to surreptitiously tax money in Roth IRA's would be to institute a national sales tax. This could be done in the name of tax simplification and could accompany a decrease in income tax rates. Then, anytime you bought anything with Roth money, you would be paying taxes that you don't pay now.

I would dearly love to see a national sales tax. There is no fairer way to tax everyone equally. Gone would be the unfair tax scales where the more you earn the higher percentage you pay. If everyone paid equally into the tax base, our collective tax rate would only be about 10% of what we make. As it is now, almost 50% of the people in the country little or no income taxes. That's why the rates are so high for the rest of us.

<<<<One way to surreptitiously tax money in Roth IRA's would be to institute a national sales tax. This could be done in the name of tax simplification and could accompany a decrease in income tax rates. Then, anytime you bought anything with Roth money, you would be paying taxes that you don't pay now.>>>>

"I would dearly love to see a national sales tax. There is no fairer way to tax everyone equally."

I do not necessarily agree, but I do not care to argue the issue today.

"If everyone paid equally into the tax base, our collective tax rate would only be about 10% of what we make. As it is now, almost 50% of the people in the country little or no income taxes. That's why the rates are so high for the rest of us."

Hardly. Do you have any numbers to support your proposition? The botton 50% earns 13-14% of all income and pays 4% of all FIT. If you raised their rate to 10%, you would not come close to dropping the rate on the top 50% (who earn 86-87% of all income) down to 10%

It has been awhile since I looked at the numbers, but, IIRC, it would take about a 20% effective rate to be revenue neutral, and it would raise the taxes on 90-95% of the population and reduce them for no more than 10% of the population, and probably more like for the top 5%.

While I am familiar with the data you cite, it is misleading, because it uses the income and taxes paid of top 5% to make the next 45% feel good.

Only the top 5% of income earners pay disproportianally more than the share of income they earn, too any significant degree, and would be the primary beneficiaries of the income tax reform you suggest.

From my notes:

The top 1% made 20% of total AGI and paid 36% of FITThe next 4% made 15% of total AGI and paid 19% of FITThe next 5% made 11% of total AGI and paid 11% of FITThe next 15% made 22% of total AGI and paid 17% of FITThe next 25% made 20% of total AGI and paid 13% of FITand the bottom 50% made 13% of total AGI and paid 4% of FIT

So, as far as FIT is concerned, the top 5% of AGI paid proportionally more (much more for the top 1%) and the bottom 90% paid proportionally less (much less for the bottom 50%).

I am familiar with the information you posted, but that is only part of the story.

The taxes that are paid under the current system allow all sorts of deductions that result in an artificially low AGI. If we had a national sales tax, there would be, by definition, no deductions! No exceptions (except maybe food stamps).

My 10% number was just a guess. Whatever the number turned out to be, it would spread out the tax burden equally to everyone, and the result would be that a large percentage of people would pay far more taxes than they do now.

rkmacdonald: "I am familiar with the information you posted, but that is only part of the story."

Definitely. Among other things, it omits a host of other federal taxes, including the 6.2% for SS (which is regressive) and the lower rates for capital gains.

"The taxes that are paid under the current system allow all sorts of deductions that result in an artificially low AGI."

I doubt that it is the bottom 50% who are claiming all sorts of deductions.

"My 10% number was just a guess. Whatever the number turned out to be, it would spread out the tax burden equally to everyone, and the result would be that a large percentage of people would pay far more taxes than they do now."

This is the first time that I have ever seen anyone claim that "a large percentage of people would pay far more taxes than they do now," while the very high income pay less in taxes, is a good thing, but I guess you have your reasons.

... they have never taken away a benefit that has already been bestowed on anyone.

This puts a (too) nice spin on taxes, I think. People who "sold" stocks--in a virtual way, the paid the tax on capital gains, and then "rebought"--again in a virtual way--so that they they could then qualify for extra low long-term capital gains rates were left high and dry as the rates fell anyway. Maybe in a technical sense "they" (= the government, or perhaps the IRS) didn't take away a benefit, but in another technical sense I think they screwed them.

This is the first time that I have ever seen anyone claim that "a large percentage of people would pay far more taxes than they do now," while the very high income pay less in taxes, is a good thing, but I guess you have your reasons

Yes, I do have my reasons! It's a matter of survival of the American way of life! We are taxing our high achievers to the extent that soon they will no longer be high achievers. Who do you think run the companies, hire the employees, fund the miracle cures, generate the growth, set the standards, etc? The high achievers!

I believe in a flat tax system, where everyone pays an equal percentage of their income to taxes. A National Sales Tax comes as close as possible to that.